Cuban economist: “I do not see a plan to reactivate the economy in the short term”

A conversation with Cuban economist and professor Oscar Fernández Estrada took on such breadth and depth that we determined it to be noteworthy and of interest to our readers. Progreso Semanal staff in Havana brings you a transcription of the complete discourse so that our readers can better understand what is happening with the Cuban economy.

How do you see the current state of the economy at this very moment? How would you characterize it?

The Cuban economy is in a very delicate situation, which has been increasing, of course, since the beginning of the pandemic, although the difficulties had begun [before the pandemic]. The causal factors of this delicate situation of the economy are known, they can be grouped into three categories. The first is that there is an external shock, the disappearance of the main sources of income. The second cause has to do with the increase in persecution, of sanctions imposed by the US government in the last months of Trump’s term, an issue that remains unchanged at the beginning of Biden’s term, and there’s nothing to relieve that tension. And the third cause, I think the most important, is the underlying structural cause, which is the exhaustion of the economic development model, understood as the structural factors of economic growth in Cuba. Added to that are the insufficiencies of the economic functioning model, which is the economic order that was intended to be modified after the 6th Congress of the CCP (Cuban Communist Party) and that really remained half-done, and not fully carried out, resulting in a truncated model halfway between a very promising reform and one that has been trapped in dogma. Recently there have been many announcements and many calls from the President to unblock that. In the last Congress he spoke in favor of continuing the reform, but there are really very few things that have been implemented in concrete terms to unblock that reform. There are many announcements that have been made over the last year, all good news, most of them are very well received, but they are only words, very little has actually been implemented.

Added to this delicate situation, which has become graver since the start of the pandemic, is the instability and uncertainty generated by the reordering of the monetary situation — a major process that modifies the foundations of the economy in general. It modifies the accounting and economic systems in state-owned companies, one of the main causes — along with the lack of a reactivation plan — of the problem. There is no plan to reactivate the economy; there is none, it does not exist, what is it? What are the measures being taken to reactivate the economy? There are actions and policies approved a long time ago, supposedly there is consensus, but where is the plan to reactivate the economy in the short term? This area seems lacking.

Inflation is accelerating. Why?

Without a doubt there is an inflationary process. What are the variables that are influencing it the most? It is very difficult to envision them while the issue is occurring because data and models would be needed in real time. But we can assume that the main cause of this process has to do, of course, with the modification of wages, prices and the exchange rate introduced by the monetary system, especially since this policy has been implemented without creating the conditions for a productive response that is broader than all its actors in the economy.

It was said and repeated by everyone involved that before the monetary reordering there was a need to expand self-employment and cooperatives so that the productive dynamics would be much faster. Furthermore, before reordering, the economy had to consolidate the decentralization of state-owned companies so that they would have much more room to maneuver before the reordering. If not the devaluation of the exchange rate does not allow the currency unification to react to the companies as quickly as they would have to if they do not have the autonomy to do so.

So this situation created confusion and was interpreted as an opportunistic proposal to expand the private sector in the economy. I think that the government allowed itself to be convinced by those whose — I’m not sure what objectives they were pursuing — dogmatic argument was that before expanding the private sector, before even expanding the TCP (self-employment), it was necessary to strengthen the state enterprise. In other words, put it on an equal footing, and the monetary reordering was the magic formula to strengthen the state enterprise. They were wrong. It turns out that it was not, and history is proving just that.

But OK, it’s done. The reordering was implemented without first expanding the possibilities of the private sector. The monetary reorder had to produce staff adjustments in the state sector because it had to produce a jump in productivity. It is still early, a year has not passed yet. Whenever there is devaluation of this magnitude there’s always a process of a few months, maybe a year, a difficult timeline to estimate in Cuba, because it depends on many factors. But in the first stage there is always a greater chance of crisis, supply chains are interrupted because businesses that were part of the chain suddenly see their production interrupted. It is normal that in the first stage there are decreases due to the losses it causes, due to the destruction that this devaluation causes in the business fabric. And it is then assumed that those that emerge victorious from that process are the ones that are going to be most productive. But that necessarily implies that there will be people who go by the wayside, businesses that close, and productive efforts that are stopped and carried out in another way, or imported, or whatever… That has to mean an adjustment. If it does not take place than you’ve accomplished nothing with the reordering since one continues to sponsor these companies. So in order to absorb that adjustment you had to have a private sector ready to fill those gaps that are not going to continue operating due to inefficiency and that can offer those products and absorb the workforce. But since it was not done, and it was started as they did… It should have been done already; I don’t understand why it has not been done.

We do not have the notion of how important time is, the temporality of things. Policies cannot be done when you want, they have to be done when the time comes. The sequence is very important, if you do not comply with the appropriate sequence, the expected impact, the positive impact can be totally diluted, and that, in my opinion, is what is happening at the moment. And we still continue to announce expansion, we continue to announce that SMEs have now been approved. Yes, they’ve been approved, but they are not implemented. And it has been more than a year since it was said that the Council of Ministers had already agreed and that they were going to expand this. Actually, for me, that is an inconceivable thing, especially when it is something that has been present in the Central Report since the VII Congress of the Party, where there is textual reference to the path through which economic policy has to advance. Five years passed and practically nothing was done, the only thing we can point to in that sense has to do with the possibility of importing and exporting; it is the only step taken, and with all its limitations.

So inflation has to do with this, with the fact that you incurred a wage increase, modified the price of all products and the devaluation of the exchange rate without the capacity for the supply side to respond. Obviously, all economic factors, including the immense scale of the informal economy, have as a natural response to increase the price of all the goods and services they offer, whether legal or illegal, and that in turn constitutes a multiplier effect and price controls go beyond the control possibilities of the state. It is impossible to control that. It is a direct consequence of the macroeconomic environment that derives from the implementation of the system without the capacity to respond to production in the short term.

Inflation is a natural process. It also is normal in a devaluation process. What happens now is that, as the devaluation was so great, there is a somewhat chaotic process in the price structure because the people, the actors, have lost their referents. One of the functions that money fulfills is that it is an equivalent, and the equivalences have been lost, because the actors are now reconstructing their notions of what is expensive and what is not expensive because prices have varied. For example, there are many actors that still trade and use the CUC as a reference point taking the rate of 1 dollar per 25 CUCs to establish their prices, the prices that are freely formed. However, many others are trading and using the dollar (in the informal market) as the exchange rate — already at close to 70 pesos per dollar.

The problem is that different paradigms or referents are simultaneously coexisting. This causes chaos in the monetary environment in terms of expectations and what works for people, also in terms of the functions of money, especially in the population sector, in the sector where prices are freely formed. It is a process that requires a little time to stabilize. Prices anchored to this structure are suffering hyper inflation. They are indexed more and more to the dollar, and if the exchange rate in informal markets is rising, then those activities that are able to are anchoring their prices to prices in the informal market exchange rate and prices in pesos may be rising rapidly.

The specific dollarization that we are seeing in the commercialization of state goods and services, do they contribute to the increased inflation?

Regarding stores in dollars, it’s a very interesting phenomenon because the increase of sales in dollars, although the data has not been published, I believe that these stores are quite stagnant. Several economists have commented that we do not understand why that cycle has not been closed. This is one of the most important things to be done. These stores were created to attract foreign currency, so if there are queues in the dollar stores it means that the mechanism is not well designed; it means that it is not working, that part of the liquidity that these stores need to replenish and fulfill precisely its function of attracting foreign currency is being taken away, part of that liquidity is being withdrawn for other purposes.

That is wrong and should not be done. These stores have to close their replenishment cycle so that they can sell more and attract more foreign currency, because otherwise these foreign currencies are captured by the intermediary, the hoarder, the person who in collusion with the grocer, with the salesperson in the store and for a commission, allows you to buy what you need without standing in a long line, and therefore can then sell the goods in the informal market for twice its dollar value. That is a significant amount that the reseller appropriates and that the State does not capture because the State could have sold two freezers, two pieces of equipment, when it is selling only one and could have made that money. That is very elementary. I do not really understand what may be happening and they have not given a convincing explanation for it.

So, certainly, a paradoxical and contradictory situation occurs where, if the sales in these dollar stores increase as they should, the demand for dollars would increase and the people who do not have dollars, or do not receive dollars from abroad, or do not have a source of income in dollars, would demand dollars with their pesos, with the pesos that come from increased salaries, pensions, self-employment activities, or whatever sources. And this increase in the demand for dollars, given that there is no official supply of dollars, creates a devaluation, a depreciation of the exchange rate in the informal market.

All this in a scenario where there are no stable dollar sources of income to the country — if there is no tourism, there is no spill over effect, there is no income in dollars directly to the population; if there are no trips, remittances slow down, become difficult, continue entering but obviously to a lesser extent than if there were trips, since the supply of dollars in informal markets does not grow, and if the demand for these dollars grows they are used in stores. So the result is that the exchange rate is affected; that’s what should happen.

Something similar happened in 1993-1994, and the State responded at a very serious moment of the crisis by creating exchange stores to intervene in informal markets, moderating those informal markets with a floating exchange rate, limited but floating, and the State managed to control an exchange rate that was above 150 pesos for 1 dollar, a figure that is possible if something is not done in the short term. If there is no intervention, not an increase in the source of entry of dollars, if something does not happen in the short term, then I think that the exchange rate will continue in an upward spiral and it is difficult to forecast how far it can go.

When we talk about inflation we almost always think about the consumer price index. We are talking about inflation in goods and services that the consumer receives, we are not generally talking about the price of goods, etc., which is another issue. And there is an important part of the economy that is not subject to these fluctuations because their prices are controlled by the State. Indeed there was an increase in bills to pay, but their rates did not increase, there might have been a change in the level of service, but the electric bill, for example, although it increases monthly, or the cost of water, for that matter, did not see a galloping inflationary process because these goods and services are identified as essential, or are provided by state companies, or are ultimately part of the standardized food basket the people receive. These goods and services underwent a price change, but that price is the same and continues to be the same and it is not growing because it is not exposed to variations in the economy — whatever happens is absorbed by the state business sector or the state budget. That is very important because it is a protection mechanism. In a scenario like this, in a much more deregulated economy, all these goods and services would be increasing as well and indeed the shock policy would be much more forceful and truly overwhelming. They are substantive differences.

In Cuba we complain about the increase in prices, or because other prices continue to increase, etc., there is a real inflationary process, but in reality there are a lot of costs protected from the process. They increased the salary and it remains to be seen if the purchasing power of people who work in the state sector increased. That data is not yet available, at least not to the public. The impact of the measure cannot be qualified, but what is certain and verifiable is that those prices are fixed at the new level and that they have not been changed. Some were corrected, some were reduced, they are negotiated with farmers and they are being lowered, but there is no dynamic inflationary process in those goods and services.

How much would this inflation and partial dollarization affect the creation of future and awaited SMEs?

Our biggest challenge right now is the dollarization situation, since these businesses would have to close a cycle. Beyond the initial investment, if a good part of the products or goods needed to continue their productive cycle have to be imported or, even more interesting, acquired in the national market from state-owned companies that are selling them in convertible currency (MLC), these businesses would then have to close their cycle in MLC, and would have to have the capacity to obtain currencies with their income in pesos and that mechanism has not been created. That is, since the state does not sell dollars under any circumstances, there is no way for someone with Cuban pesos to buy dollars in order to pay in dollars for the goods you need for your productive process. And while more state companies are looking to solve their profitability problems with national currency, and are allowed commercialization in freely convertible currency, and the dollar economy expands, since goods will be hard to find with national currency, we should therefore close the national currency cycle.

Those are the paradoxes of this process, because for state-owned companies, many of them, in order to get ahead, should be allowed to operate in the segment of the economy that is dollarized; in other words, the goods and services they have to sell in pesos, that they sell them in dollars thereby closing the cycle and participating in the collection of dollars that can be found in the country. If you do that, though, you expand dollarization and make it more and more difficult for the productive cycle to close. This then creates a situation where there is a limited supply of goods in pesos because most  actors offer them in dollars they need to close their productive cycle, not because they want to earn income in dollars per se, but because they need to close their productive cycle and to acquire goods in dollars. It is that or create a currently non-existent exchange mechanism that is only found in the informal markets for non-state actors. These are the great paradoxes of this process that require a much more systematic and harmonious intervention by the State than what, in my opinion, is being done at the moment, or at least what has been publicly reported.

Right now future SMEs are very impacted by this situation of monetary chaos because any feasibility calculation is exposed to big errors since you necessarily have to estimate an exchange rate. Which begs the question: What is the exchange rate? Any new project requires an initial investment, no matter how small. This investment will be made in, except in certain cases, equipment or supplies that one uses in a first stage of the project. There is a high probability that these supplies will be imported through of the mechanism of state importing companies or through other mechanisms, but they will surely be imported, and therefore that initial investment will have a high component in foreign exchange, dollars that have to enter into your feasibility analysis in some way and be combined with the pesos in which you are going to obtain income if your business is aimed at the domestic market, because you cannot aspire to sell in dollars because that is not a certainty. So any such analysis requires an exchange rate. At what rate are you going to calculate this? There is great uncertainty.

Entrepreneurs will always assess their scenarios and see if the business is feasible depending on the exchange rate. They will establish a range and make their evaluations, but there will always be great uncertainty associated with this. At the same time there is a great advantage. The advantage being that in such a crisis situation, with so many resource shortages, and such a great lack of supply, practically any undertaking that produces something can find a market, and more when there is a wage increase and there is an inflationary process. Whatever is being offered will find a buyer because there is money… the problem is that there are no goods to buy. So that is, let’s call it the positive part, startups that emerge in a crisis generally have a greater chance of success, at least in the short term, because there is an unmet demand for many things and there is money waiting for goods to appear in order to buy them. And that’s a bonus.